Unfair but balanced commentary on tax and budget policy, contemporary U.S. politics and culture, and whatever else happens to come up

Wednesday, February 24, 2010

Wyden-Gregg tax reform proposal

Senators Ron Wyden (D-Ore.) and Judd Gregg (R-N.H.) have introduced the "Bipartisan Tax Fairness and Simplification Act of 2010" (summarized here). They deserve a degree of praise for even trying this. But I suppose it's my job to examine the details critically without extending sympathy points for their need to keep in mind political feasibility issues.

Too many features to comment on all of them here. But some of the key ones include the following:

--3 individual income tax brackets (at 15, 25, and 35%) instead of 6. This is touted as simplification, but is entirely trivial in that regard. Presumably. most people simply look at the income tax tables to see how much they owe.

--Eliminate alternative minimum tax. Great, but the hard part is paying for it. According to the Congressional Research Service, despite base-broadeners they fall $230 billion short of revenue neutrality over 10 years (relative to an Obama Administration budgetary baseline that, needless to say, falls far short of long-term sustainability), and propose to pay for it by "cutting an average of $23 billion per year from corporate and business-related spending and transfers." These are of course unspecified, and good luck finding reductions that Congress would accept (although finding enough that ought to be cut would no doubt be easy). For a general list of their revenue offsets, see this.

--Near-tripling of standard deduction. In principle, a good way to lower tax burdens on the bottom of the distribution and to devalue itemized deductions that ought to be repealed but are politically embedded. I believe they don't phase it out, which might make little difference at higher income levels (if people mostly switch to itemizing anyway). But with a much larger standard deduction and, perhaps, lower qualified residence interest deductions in the future (from reduced home values and borrowing), conceivably standard deductions would be used much further up the scale than is now typical.

--Itemized deductions, including bad ones such as the qualified residence interest deduction, are generally retained, and no longer phased out. In general, the phaseouts make no sense as such - they are better thought of as temporarily high "bubble" rates, and evaluated based on what one thinks of such a rate structure - but this does modestly increase the deductions' value among those who ARE itemizing. Lost opportunity to use tax reform as a way of scaling these deductions back, e.g., by converting them to a 15% refundable credit. Interestingly, they do apparently convert the exclusion for municipal bond interest into a percentage credit.

--Itemized deductions currently subject to the 2% of adjusted gross income floor are repealed. Some of these items actually are costs of earning income, however.

--Consolidated and expanded retirement savings provisions. I'm in favor (makes it more of a consumption tax), but am concerned about the issue (under current law as well) of deductibly borrowing on one's home to finance supposed retirement saving.

--Lowers the U.S. corporate rate to 24% (while eliminating the farcical rate graduation in current U.S. corporate tax law). Good for attracting more investment $$, or simply reported taxable income by multinationals with planning flexibility, to the U.S. in competitive world capital markets. But with the corporate rate at 24% versus a top individual rate of 35%, they need to address the problem of high-earners transmuting their earnings into corporate income from their closely held companies.

--Elimination of a variety of special interest tax breaks. Great, if one can do it. This is indeed what 1986-style comprehensive tax reform is supposed to emphasize. Most of the items they list (which you can find on the links I provided above) are well worthy of repeal; for a few this could be challenged.

--Limit corporations' interest deductions to real interest (i.e., nominal interest is reduced by the inflation rate in determining what's deductible). This is a bit odd, given that nominal interest and other inflationary aspects of gain continue to be taxable elsewhere. They tout it as reducing the debt bias of current corporate tax law. But that really is a distinct issue from the inflation problem, which in theory (i.e., subject to administrative concerns) calls for comprehensive inflation adjustments for everything. A bit cute to try to address the more general debt issue this way - not sure it makes sense unless one posits that this is more politically feasible than more straightforward approaches.

--Move towards a more worldwide system for taxing U.S. companies foreign source income. In particular, they repeal deferral for business income that U.S. companies earn through foreign subsidiaries, and reinstitute the per country foreign tax credit. No doubt they (or perhaps more Wyden on the Democratic side) think of this as a key tradeoff for lowering the corporate rate, but perhaps not the best direction to go in given the increasing electivity of U.S. corporate residence. The domestic tax rate for all corporations operating in the U.S. and the treatment of foreign source income earned by resident U.S. corporations really are different margins.

Considered as a whole, this bill is potentially a good conversation-starter, but somehow I doubt that the conversation will get very far. I remain skeptical about the political prospects of using base broadening to pay for rate cuts, higher effective zero bracket, etcetera. Perhaps we could do this for corporations - lower corporate rate plus base-broadening and provisions to prevent individuals from exploiting the lower rate through closely held companies. Insofar as academics and policy types are deciding where to concentrate their fire, I'd place more emphasis on the long-term fiscal problem and likely need for a VAT to help stave off actual or implicit default by the federal government. Plus, if the rise of the AMT becomes politically salient to voters, financing its repeal through curtailment of itemized deductions and other personal income tax benefits might make sense, but the time for that does not yet seem to have come.

In sum, rather than try a general 1986-style reform, I'd propose emphasizing (1) raising revenues through a VAT, as part of a broader deal that addresses entitlements growth and perhaps purports to dedicate VAT revenues to particular purposes, (2) a narrower trade of rate reduction for offsets (other than increasing U.S. worldwide taxation) specifically for corporations, and (3) a similar trade with respect to individuals' targeted tax benefits and AMT repeal, if and when voters become concerned enough about the AMT for this to be feasible.

9 comments:

You failed to mention the proposed law also eliminates the Foreign Earned Income Exclusion which would expose millions of Americans abroad to double taxation. Already the US has 1/3 as many citizens living abroad per capita as compared to other OECD nations. Increasing levels of double taxation will only drive more Americans home to the unemployment line and further deepen our trade deficit as no "salesmen" are left out in the world.

Yes, I saw that but figured I can't comment on everything in the bill. I probably wouldn't view the domestic unemployment effects as direly as you do, but I'm skeptical about the proposed change (although I haven't thought as much about international tax issues involving individuals as corporations).

It's a provision that hits a population as big as the state of Kentucky. Perhaps it's just coincidence but our trade deficit started right about when Congress began taxing a portion of foreign earned income. Many Asian and European nations have positive trade balances with China, even as some of them import more per capita than the US does. Would we expect to win a war with 1/3 fewer troops in the field than our enemy? Do we expect our products to sell and service themselves? Since we are the only nation doing this and it obviously isn't working, hmm. Shouldn't we question that strategy? As far as domestic impacts, just ask the Germans what exports can do for employment. And now is a bad time to have hundreds of thousands of citizens returning home looking for jobs. Ask someone what happened the last time Congress repealed the exclusion in 1978. They realized within 9 months what a stupid mistake it was and reinstated the exclusion retroactively. Though not after much damage was done. Ex: People forced to shut down businesses importing US equipment and return to the US.

Over the past 30 years Federal Tax receipts (Corporate, Personal, Estate, Excise, Gift, Social Security, Medicare, Medicaid, et al) have averaged less than 20% of Gross Domestic Product (GDP). Read that again, and don't think for a minute that it's not a large number.

But it's not nearly large enough to pay the bills, reduce the national debt, grow the economy, and come to the aid of all of the people in the world who need us. Why, because nearly half of us (some legally, some not so) pay little or no federal income taxes at all--- and because our elected representatives have no financial management skills.

The only taxes that always get paid are those that reduce the amount of spending money in our pockets and which raise the cost of the goods and services we purchase --- thus retarding economic growth.

First KISS: Create Jobs Right Now

Create jobs immediately by eliminating the corporate income tax (and all other fees, local taxes, assessments, ad nauseum) for any corporation that adds 10% to its permanent workforce and/or 20% to its total workforce.

Second KISS: Lower and Eliminate Taxes

Third KISS: Produce Sustainable Economic Growth

"The Rest of the Story": http://kiawahgolfinvestmentseminars.net/Inv/index.cfm/6942

Steve Selenguthttp://www.kiawahgolfinvestmentseminars.com/ http://www.sancoservices.comProfessional Portfolio Management since 1979Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read"

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the deductions' value among those who ARE itemizing. Lost opportunity to use tax reform as a way of scaling these deductions back, e.g., by converting them to a refundable credit. Interestingly they do apparently convert the exclusion for municipal bond interest into a percentage credit. Matawan Tax Return Service

About Me

I am the Wayne Perry Professor of Taxation at New York University Law School. My research mainly emphasizes tax policy, government transfers, budgetary measures, social insurance, and entitlements reform. My most recent books are (1) Decoding the U.S. Corporate Tax (2009) and (2) Taxes, Spending, and the U.S. Government's March Toward Bankruptcy (2006). My other books include Do Deficits Matter? (1997), When Rules Change: An Economic and Political Analysis of Transition Relief and Retroactivity (2000), Making Sense of Social Security Reform (2000), Who Should Pay for Medicare? (2004), Taxes, Spending, and the U.S. Government's March Towards Bankruptcy (2006), Decoding the U.S. Corporate Tax (2009), and Fixing the U.S. International Tax Rules (forthcoming). I am also the author of a novel, Getting It. I am married with two children (boys aged 16 and 19) as well as four (!) cats. For my wife Pat's quilting blog, see Patwig’s Blog.